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Roten Manufacturing Company is considering an investment on a machine for produc

ID: 2783606 • Letter: R

Question

Roten Manufacturing Company is considering an investment on a machine for producing auto parts. The machine costs $250,000 today, will have a five-year life and will be depreciated over a five-year life on a straight-line basis toward a zero salvage value. The company paid a consulting company $7,000 last year to help them decide whether there is a sufficient demand for the auto parts. In addition to the investment on the machine, the company also invests $15,000 in net working capital. The company has estimated the performance of the new machine and believes the following are good estimates of the new asset: sales $140,000 per year, cost of goods sold (35% of sales) per year, and administrative expenses $15,000 per year. The company pays interest $20,000 annually on average, has a 10% cost of capital and a 30% tax rate. Answer Questions 1 - 8.

Question 5

What is NPV for the project?

$2,845.48

-$31,469.12

$1,653.45

-$6,468.34

Question 6

What is IRR for the project?

10.41%

9.04%

11.73%

8.52%

Question 7

What is PI for the project?

1.01

0.98

0.94

1.89

Should Roten accept the project?

No

Yes

a.

$2,845.48

b.

-$31,469.12

c.

$1,653.45

d.

-$6,468.34

Question 6

What is IRR for the project?

a.

10.41%

b.

9.04%

c.

11.73%

.

8.52%

Question 7

What is PI for the project?

a.

1.01

b.

0.98

c.

0.94

1.89

Should Roten accept the project?

a.

No

b.

Yes

Explanation / Answer

Sales 140000 Cost of goods sold (35%) 49000 Administrative expenses 15000 Depreciation (250000/5) 50000 Incremental operating income 26000 Tax at 30% 7800 NOPAT 18200 Add: depreciation 50000 OCF 68200 5) NPV: PV of annual operating cash flows = 68200*(1.1^5-1)/(0.1*1.1^5) = $   258,531.66 PV of NWC recaptured = 15000/1.1^5 = $        9,313.82 PV of cash inflows $   267,845.48 Initial investment (250000+15000) $   265,000.00 NPV $        2,845.48 Answer: Option [a] $2,845.48 6) IRR is that discount rate for which NPV = 0. Hence, 265000 = 68200*PVIFA(irr,5)+15000*PVIF(irr,5) The value of IRR is to be found out by trial and error. Discounting with 11% NPV = 68200*3.6959+15000*0.59345-265000 = -4037.87 For 10% NPV = $2845.48 For 11% NPV = -$4037.87 So discount rate for 0 NPV lies between 10% and 11% The value of r (IRR) = 10+2845.48/(2845.48+4037.87) = 10.41% Answer: Option [a] 10.41% 7) PI = PV of cash inflows/Initial investment = 267845.48/265000 = 1.01 Answer: Option [a] 1.01 SHOULD ROTEN ACCEPT THE PROJECT---- YES Because NPV is positive, due to which IRR>WACC and PI>1.